Education

Are no-interest loans a simple fix to the student debt crisis?

This audio is auto-generated. Please let us know if you have feedback.

Dive Brief:

  • Federal policymakers should offer no-interest student loans to prevent borrowers from paying more than their loans’ initial value, according to a Boston-based nonprofit group focused on college affordability and lobbying against student debt.
  • The proposal, outlined in a report from the Hildreth Institute, seeks to address the growing number of borrowers who become trapped in loans with negative amortization — borrowers making payments on their loans that don’t cover accumulating interest, resulting in a loan balance that grows.
  • Under Hildreth’s plan, the government would offset the costs of interest-free loans by investing the principal repayments in risk-free assets, like Federal Reserve bonds. This could generate a return that would cover administrative costs.

Dive Insight:

President Joe Biden continues to mull over possible variations of wide-scale student loan forgiveness, including one plan from the U.S. Department of Education that reportedly could cover several million borrowers. That would make good on a campaign pledge Biden made to forgive at least $10,000 per borrower, but critics argue debt relief without reforms to the student loan system will leave future borrowers in the same predicament as those who owe money today.

Hildreth’s proposal argues interest-free federal loans would provide a sustainable solution by keeping loan balances from skyrocketing and avoiding the need for periodic loan forgiveness.

“An unintended result of our current system means that borrowers in financial hardship end up paying more over the lifetime of their loans than wealthier borrowers,” the report said.

Some borrowers found temporary relief under a federal student loan repayment moratorium. In response to the pandemic, the Ed Department paused all federal student loans beginning in March 2020. Loan interest rates dropped to 0% while the Department suspended payments and stopped defaulted loan collections. 

The relief program has been extended several times and is currently set to expire at the end of August.

Under Hildreth’s proposal, interest rates would remain at 0%, and students could direct their money to the balance of their loans. For borrowers carrying the average debt load of $35,000, a no-interest loan would reduce monthly payments under a 20-year repayment plan from $383 to $145, the report said.

In 2019, almost a quarter of all student loan payments went to interest, not loan balances, according to the report. The value of those interest payments, $22.4 billion, was up from $13.1 billion in 2015. 

The amount is expected to rise, as interest rates for new undergraduate student loans are predicted to increase from 4.99% to 5.85% over the next decade, according to a May report from the Congressional Budget Office.

Income-driven repayment plans are a popular option for borrowers facing large payments, but the report said they present complexities and challenges. IDR plans allow borrowers to adjust monthly payments in accordance with their income and family size. While this makes regular payments more manageable and can help keep people out of default, it can often lead to negative amortization.

IDR plans typically run for 20 or 25 years and forgive remaining debts at the end of that period. But the balance of the dismissed loans are taxable and have often ballooned by that point, according to the report.

Having an IDR plan with an astronomical dollar amount attached is also stressful and disproportionately affects Black borrowers and their mental health, Hildreth argued.

Nearly half of undergraduate loan balances held by Black borrowers grow after graduation, compared to less than one-fifth of balances held by White graduates, according to a 2016 Brookings study cited by the report.

Among Black borrowers with IDR plans, 67% reported that the loans negatively impacted their mental health, according to a 2021 survey from Education Trust.

Hildreth argues that interest-free loans would be simpler for the federal government to manage and prevent borrowers from carrying the financial and mental burden of an ever-increasing balance.

 Source link

Back to top button
SoundCloud To Mp3